Treasurys post modest gains

Stock weakness, Jeffords political shift are supportive

By

RachelKoning

NEW YORK (CBS.MW) - Short-dated Treasury securities edged higher in a lackluster Wednesday session devoid of a catalyst save for modestly bond friendly political news and the stock market's turn lower.

The bond market was largely treading water ahead of economic data later in the week and a Thursday night speech from Alan Greenspan.

Profit taking and weakness in the semiconductor and networking segments snapped the Nasdaq's six-day winning streak and tugged the broader equity markets lower. Read more in Market Snapshot.

Reports that Vermont Republican Sen. James Jeffords will switch his party affiliation and give the Democrats the narrow majority in the Senate is ultimately bond friendly because it could make it harder for the GOP to pass an aggressive tax -cut agenda.

"With stocks in an upward tract and bonds in a downward one, Democratic control of the Senate would likely spark a consolidative trend [for Treasurys], especially with the bond-friendly and stock-unfriendly economic data likely to be released over the next week," said Tony Crescenzi, bond market analyst with Miller Tabak & Co.

The Senate did vote 62 to 38 in favor of a $1.35 trillion 11-year measure on Wednesday afternoon and will have to reconcile their version of tax-cut legislation with the House draft. Get the full story.

Jeffords had already organized with a group of centrist lawmakers from both parties who are in favor of tax relief but were influential in scaling back President Bush's initial $1.6 trillion proposal.

Bond investors can find a couple of bullish implications in such a scenario. First, many economists point to any retroactive tax rebates as helping to stimulate the nation's growth later in the year.

The long bond has weakened in recent sessions on ideas the recovery will be pronounced enough to rekindle inflation. Inflation chisels away at the worth of a fixed security, particularly a Treasury bond because it is exposed for a longer period of time.

Additionally, fixed-income investors believe that if the nation's budget bounty isn't largely earmarked for tax cuts, more funds could go to debt reduction, which will limit the supply of Treasury securities.

Bondholders are equally leery however of large government spending initiatives, which would tie up the surplus.

"But since the ultimate result is gridlock, and the markets generally like Washington to be a neutral factor, the initial knee-jerk response could ultimately be reversed, be it in hours, day, or weeks," Crescenzi said. "Still, today is likely to be a good day for bonds and a bad day for stocks."

The government already has been using budgetary windfalls to reduce its debt holdings. Officials announced Wednesday its plans to reclaim up to $750 million in old callable 30-year bonds on Thursday, part of the Treasury's now-standard buyback operations.

The debt would have matured between February 2010 and November 2014. And because it carries risk that the government can "call" back the debt ahead of maturity, coupon interest rates range from between 10 and 14 percent.

At the 3 p.m. U.S. close, a 10-year Treasury note was up 4/32 at 97 2/32 to yield
TNX, -1.21%
5.39 percent or a loss of 2 basis points, while the 30-year government bond, which has crossed over from negative to positive and back throughout the session lost 1/32 at 94 9/32 to yield
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an unchanged 5.78 percent.

A 2-year note was up 3/32 at 99 16/32 with its yield off 5 basis points at 4.27 percent, while a 5-year note rose 4/32 at 98 18/32, to yield 4.95 percent or a loss of 3 basis points.

Yields and prices move in opposite directions because the higher price of a fixed security cuts into its return and vice versa.

Housing statistics, durable goods orders and revised growth figures will be released in the next couple of days. But the week's marquee event is Fed Chairman Alan Greenspan's speech to the New York Economics Club, scheduled for 8:20 p.m. View Economic Preview and economic calendar and forecasts.

As for currencies, dollar/yen dropped 1.3 percent to 121.20 while euro/dollar continued its descent, erasing 0.8 percent to 0.8582 and again hovering at levels not seen since late November.

As had been expected, the European Central Bank left short-term rates unchanged at its policy-setting meeting.

In other market action, Fannie Mae
FNM, +3.87%
on Wednesday sold a total of $10 billion in new 2-year and 10-year notes.

The mortgage lender offered $5 billion of new 2-year at a 5.625 percent coupon to yield 4.664 percent or 38.5 basis points more than a comparable-maturity U.S. Treasury.

Also sold were $5 billion of 10-year notes carrying a 6 percent coupon to yield 6.089 percent or 68.5 basis points over Treasurys.

Debt offered outside the Treasury arena adds to overall fixed income supply and competes with government issues. Many investors have been seeking out higher return - even if it means taking on more risk - in an environment where the Fed has been cutting interest rates.

Data from the Mortgage Bankers Association of America showed that U.S. mortgage refinancing activity fell to the lowest level since early January. Its index for the week ended May 18 fell 20.6 percent to 1,546.8, its lowest level since 1,572.1 posted for the week ended Jan. 4.

Mortgage-backed security traders said refinancing activity was expected to reside now that bond investors believe the Fed is nearing the completion of its rate-cut campaign and have driven Treasury yields higher.

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